Corporate Governance

Portnoy v. Cryo-Cell: Vote Buying, Manipulation of the Voting Process, and the Race to the Bottom (Part 1)

By J. Robert Brown

As the new year progresses, we have our first candidate for next year's list of the most anti-shareholder cases decided by the Delaware Court of Chancery, Portnoy v. Cryo-Cell, CA No. 3142-VCS, Del. Ch., Jan. 15, 2008, a 73 page tome written by VC Strine. (For last year's list, go here).  And we say that even though shareholders to a degree got some of the relief they were seeking. 

The case involved a proxy contest for control of the board at Cryo-Cell.  Cryo-Cell is well known to the regular readers of this Blog because it is the only companywhere shareholders have approved an access proposal.  At the same meeting where the access proposal passed, management won a narrow victory in a contest for control of the board.  The law suit sheds some light on what happened in the run up to the meeting.

The early tallies showed that management was about to lose the election.  According to the opinion, the CEO embarked on a strategy designed to ensure victory. The strategy included:

• an arrangement with a large shareholder to obtain support by adding him to management's slate and later to provide him with an additional director in return for purchasing "enough shares to turn the tide."  The designee would be a "subordinate who had within the recent past resolved an SEC insider trading investigation by agreeing to disgorge trading profits and to be jointly liable for trading profits made by his tippees." This arrangement was not disclosed to shareholders; and 

• "a combination of threats (the ending of cooperation on key projects) and inducements (the long-sought but never before granted removal of a restrictive legend) to secure the vote of [another large shareholder]. That leverage was enhanced by the fact that Cryo-Cell owned 38% of [large shareholder's] shares and that [large shareholder] depended on Cryo-Cell's laboratory space to conduct many of its own operations."

Indeed, the opinion described the CEO's behavior as "desperate and, frankly, irrational" and noted that she, among other things, sought to have the FBI intervene in the contest.     

At the meeting itself, the questionable efforts continued.  Still unsure of victory, the CEO essentially arranged to have her own meeting filibustered, providing additional time to ensure that certain votes were cast properly.  According to the opinion:

• So she had members of her management team make long, unscheduled presentations to give her side more time to gather votes and ensure that they had locked in two key blocs. She overruled motions to close the polls. Even after the filibusters, [the CEO] still harbored doubt that the Management Slate would prevail if the vote was counted and the meeting was concluded. So, at around 2 p.m., [the CEO] declared a very late lunch break, supposedly in response to a request made much earlier. In fact, [the CEO] desired the break so that she would have more time to seek votes and so that she could confirm that the major blockholders had switched their votes to favor the Management Slate. Only after confirming the switches did Walton resume the meeting at approximately 4:45 p.m. , declare the polls closed, and have the vote counted. The post-meeting vote count resulted in the Management Slate squeaking out a victory by an extremely small margin. (record citation omitted).

Needless to say, Plaintiff, the dissident shareholder, challenged these results.  He got a new election, not because of the combined behavior of the CEO, but mostly because the CEO failed to make adequate disclosure. 

His reward?  Neither attorneys fees nor the costs associated with the proxy contest.  The previous board was reinstated (apparentlyincluding the CEO who fought so hard to defeat the Plaintiff's efforts), effectively allowing management to remain in power.  The court did exclude the large shareholder from the board, an action that disadvantaged the large shareholder but probably benefited management since the director was added out of necessity to obtain the large shareholder's support.  In other words, as a result of the CEO's apparently egregious behavior, the CEO benefited.  

Management was ordered to hold a new election and to pay its own proxy expenses (as well as the costs of the meeting and a special master to conduct the meeting).  Not an insignificant expense, perhaps, it still left the Plaintiff with the obligation to pay a second time for the costs associated with the solicitation of proxies for its own nominees (The access proposal won't help.  The proposal would only allow for a short slate.  Plaintiff wants control). 

Management engages in what the court describes as vote buying, filibusters its own meeting, and uses coercive tactics to secure votes of a shareholder.  For this behavior, management is allowed to remain in office, a director management likely did not want on the board is excluded, and Plaintiff is forced to incur delay, attorneys fees, and, for the second time, the costs of a proxy solicitation.  In Delaware, even when shareholders win, they often lose. 

We will explore what happened in the next several posts.  Primary materials, including the case, can be found at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on February 07, 2008 (boomark / email).